Explaining the value of the 0% credit card

Professor Phillip Braun of Northwestern’s Kellogg School of Management specializes in the study of the interaction of the macroeconomy with financial markets. He is the author of a number of articles, most recently a series of papers studying Islamic economics, as well as an online columnist for Forbes.

Here he discusses the ins and outs of the 0% credit card, how it’s used and how it can benefit both the consumer and the lender.

Why do banks offer 0% credit cards?

To get new customers. Typically 0% cards will have a very high-interest rate after the introductory period (the grace period), so they can be very profitable.

Are 0% credit cards a trap?

Not necessarily, it depends on how the cards are used — the cards need to be used wisely.

If someone is going to make regular payments on the card and pay off the balance during the grace period, the cards can be helpful for borrowers.
If a borrower takes cash advances, misses a payment, or carries a large balance when the grace period expires, then the borrower has trapped themselves into an unfortunate situation.

What types of expenses should a 0% credit card be used for, and vice versa?

Typically they should be used for large purchases that will be paid off during the grace period.

Given that most balance transfers are not paid off during the grace period and the 0% APR card will most likely have a very high-interest rate after the grace period, plus they can be charged a balance transfer fee of up to 5%, balance transfers should be conducted carefully or avoided.

Cash advances are also not recommended because they often do not qualify for the 0% APR and are charged a very high-interest rate. Furthermore, when a borrower makes a minimum payment, that payment goes towards paying off the balance on charges subject to the 0% APR rate, not the higher rate.

Finally, any charges that will not be paid off by the end of the grace period should be avoided.

How much is a 0% intro rate worth to a consumer? And how does the length of that intro term affect the value?

We can understand the worth of the card via an example. Assume a consumer buys a new refrigerator for $2,000 and plans to pay it off in 12 monthly installments.

If she uses a credit card with a 20% APR, across the year she will pay almost $225 in interest, vs., of course, zero interest payments for the 0% APR card (assuming she does not miss a payment).

So, the cards can be very valuable to consumers if they are used correctly.

Continuing the above example, if instead, she pays off the refrigerator across 24 months at 20% APR, she will pay almost $445 in interest.

So, the longer the grace period lasts, the better it is for the borrow.

Are 0% credit cards immoral because they encourage debt?

Individuals need to control their own borrowing habits.

Clearly, if 0% APR cards are being used to transfer large balances, the borrower already has spending and borrowing problems, independent of the 0% APR cards.

If 0% APR cards are used carefully, they can help borrowers reduce the burden of their debt.

If they are not used carefully, the borrower pushes themselves into a worse situation than where they started.

Are 0% credit cards to blame for rising credit card debt levels?

Most recently, rising credit card debt levels are the result of declining family incomes due to the pandemic. If anything, 0% APR cards are helping families manage during this time of crisis.

This Q&A was originally published on WalletHub.